Some News that Matters

It was just last week that one of our members in Italy said that to withdrawal more then $2,000 Euros from the bank, you had to place an order and then the bank would call you to tell you when they had the money and when you can pick it up, imagine that here in America!

As the member noted in his email to me, he didn't understand why the banks had no liquidity on hand.

This is called short term capital markets freezing up and is exactly what happened in the US that was partially to blame for bringing dow Lehman Brothers as well as starting unprecedented F_E_D_ liquidity operation to unfreeze the capital markets.

What causes this? In three words, "Counter Party Risk". This is what I described two weeks ago as mistrust and that is what creates the beginning of the end for markets. Banks routinely have overnight borrowing operations, but when one bank doesn't know what the other banks's true risks are, they are afraid to lend anything, even overnight, so banks end up without liquidity and we call that a short term credit market freeze. Little has been done to repair this and it seems other then outright monetization, little can be done, although the F_E_D has extended swap lines to Europe to try to help with dollar liquidity.

So last night I ran across this story, which explains exactly why our Italian member must wait to withdrawal funds until the bank has them. Comments to follow the article excerpts.

From the NYT Dealbook:

Banks in Italy Find an Unusual Liquidity Lifeline

The London Stock Exchange is becoming the lender of last resort for many banks in Italy as concerns over the country’s debt levels squeeze liquidity out of the Italian financial market.

Under terms of the deals, the clearinghouse, which acts as a middleman to guarantee trades between financial parties, is offering money to both Italian and European banks with a presence in Italy for up to three days.

The money, which comes from collateral that traders must put up to complete financial transactions, is deposited with the banks to cover shortfalls in liquidity. CC&G earns a profit by charging banks interest on the money that they borrow.

Previously, banks had used the so-called repo market, where banks lend capital to each other on a short-term basis, to meet their financing requirements. But fears about Italy’s ability to repay its debts has pushed up borrowing costs and reduced the ability of banks to access that market.

CC&G also doesn’t technically lend money to banks, but instead deposits the cash with them on a short-term basis. Under Italian law, this distinction makes CC&G a depositor with the banks, and places it ahead of other creditors looking to get their money back if any financial institution should fail.

The Italian business now represents 14 percent of the exchange’s overall income, compared with just 5 percent in the first half of 2010.

With so much news out there, it can get tiresome and everything just kind of blends in to a massive blur of news that leaves you asking yourself, "How is any of this relevant to me, why bother?"


I submit to you, this is one of the most under-appreiated and most dangerous stories we have seen this week.


Think about this, the traditional source of bank liquidity have either dried up, they don't trust each other or the rates to borrow money over very short terms are so high that it is prohibitive.


Now imagine this was happening in the USA and keep MF Global in mind at all times. The credit markets freeze, GE can't make payroll because their (hypothetical) bank, Bank of America has no money to give GE come Friday (and this situation DID happen with GE in particular in 2008). So the New York Stock Exchange takes money, maybe traders margin money, maybe money that has been used to buy 1000 shares of APPL (after all there is a Trade + 3 day settlement rule) and the NYSE lends money to Bank of America at an interest rate for 3 days which is convenient with the T+3 rule.


That is how bad the situation across Europe is, the London Stock Exchange is using their client's/trader's money to lend to EU banks and make a % on each loan.


Now imagine because of Bank of America's huge exposure to Greece, they go bankrupt as Greece defaults on all debts, guess what? The NYSE, even though it has first lien position, just lost a sizable amount of the trader's capital, just like MF Global.


This is how bad the situation is and how desperate banks are to find any kind of money available to them!


This would also explain why in Italy you must wait for your money as it is being lent at an interest rate, they don't want to order any more money then absolutely needed otherwise they pay interest on capital that may not be used.


This is astounding news and introduces a whole new lass of moral hazard and as usual, incredibly dumb decisions taken by everyone in the EU with little thought, except this isn't out of survival for the London Stock Exchange, it is pure greed.


When I said we would see things we can't even imagine and the consequences will be beyond our imagination, you just saw one of those things.